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Quarterly Economic Overview - 2011 Q3

With the world economic recovery in a soft patch, Mexico's growth rate is continuing to moderate.  In the second quarter of 2011, Mexican gross domestic product (GDP) was up 3.3% from the same period one year earlier.  That was very close to Mexico's average annual growth rate of 2.8% from 1990 to 2010.  However, it was significantly weaker than the year-over-year gains of 4.6% in the first quarter, 4.4% in the fourth quarter of 2010, and 5.1% in the third quarter of 2010.

International trade continues to be a source of growth for Mexico, though the dynamics have weakened.  On a seasonally-adjusted basis, the trade balance has shifted back to modest deficits after an unusual period of surpluses in late 2010 and early 2011.  Export growth in recent months has averaged approximately 20% year-over-year, versus gains in excess of 30% one year ago.  Likewise, industrial production is not growing as fast as a year ago, and output gains are becoming choppier, although that may in part reflect the March earthquake in Japan and the resulting disruption in global supply chains.  With cooling exports and softer industrial production, hiring has weakened, and unemployment in recent months has rebounded to 5.7%, close to the cycle peak of 5.9% in September 2009.  Surveys show consumer confidence is still relatively high, but retail sales growth has slowed.

Mexican stability indicators remain healthy, though they have deteriorated modestly in recent months.  Consumer inflation rebounded to 3.5% in July, but price increases remain close to the central bank's target of 3.0%.  Banco de México continues to keep its benchmark interest rate at a historically low 4.50%, just as it has since July 2009, and it has given no signal of any change in the near term.  The government also continues to exercise reasonably good fiscal discipline.  Official data show Mexico's public-sector deficit stood at 2.3% of GDP in 2009 and 2.8% of GDP in 2010, and figures from January through June of this year suggest a similar deficit in 2011.  For comparison, the Organization for Economic Cooperation and Development (OECD) recently estimated the U.S. deficit was 10.6% of GDP in 2010.  Official figures show Mexico's public-sector net debt stood at 25.0% of GDP at the end of 2010, while the OECD says U.S. net debt stood at 67.3% of GDP.

Decent economic growth, relatively high interest rates, and healthy public finances continue to attract international capital into Mexico.  Central bank data show foreign direct investment in Mexico (net foreign purchases of land, factories, offices, and other hard assets) rose to $6.1 billion in the four quarters ended March 2011, compared with a revised $4.3 billion in the four quarters ended December 2010.  Portfolio investment (net foreign purchases of Mexican stocks and bonds) fell to $38.7 billion in the last four quarters, but that was still close to the record $39.4 billion in the preceding period.  These capital flows have been more than enough to cover the country's current account deficit.  They also put strong upward pressure on the peso.  Based on figures from the U.S. Federal Reserve, the peso's spot-market value at the end of June 2011 rose to $0.08471 (11.81 per dollar), up 24.1% from its mid-recession low in March 2009.  As the world's financial markets faltered in mid-summer, however, capital flows into Mexico appear to have weakened, and the peso has pulled back sharply.

In the coming months and quarters, the Mexican economy is expected to continue growing.  Even slow growth in the United States should be enough to keep Mexican exports expanding and domestic demand recovering, but the overall rate of growth is likely to keep moderating.  The International Monetary Fund currently forecasts Mexican GDP growth will come in at a strong 4.7% in 2011, before slowing to just 4.0% in 2012.  The main near-term risk is that the key developed countries could slip back into recession.  In addition, rising drug violence could become so bad that it weighs more noticeably on domestic economic activity.  Mexico also faces future fiscal challenges if its oil production continues to decline.  Most important, the country is unlikely to keep growing well unless it implements key economic reforms, such as breaking up monopolies, deregulating the labor market, opening more industrial sectors to private investment, and otherwise increasing competition and investment.

Patrick Fearon, CFA
Vice President, Fund Management

Special - TNV Quarterly 2011 Q3

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